You are going to love this one…
Another Wall Street myth is about to get completely blown out of the water.
And it’s one that you have heard your entire investing careers…
But it makes sense right?
When we buy a house…we buy insurance to protect ourselves from something like a natural disaster!
So why don’t we do the same in the markets?!?!
In this article, I will explain why buying protection is guaranteed to lose you money over time and exactly what you can do instead that gives you a much better chance of making money.
Look, everyone, it cannot be done.
But in case you want a refresher of what can be done take a look at this video from the Investment Professional:
Let’s go through the three tips Jason speaks about above.
Buy Insurance for Your Portfolio
Jason gives the example of what he calls a “Married Put” to buy insurance for your portfolio.
A married put being buying one put option for everyone 100 shares of stock purchased.
Let’s look at an example:
Here we are buying 100 shares of the SPY at the closing price from Friday $216.30 while at the same time purchasing one put 5% below the market.
In this case, we are purchasing the 18 Nov 16 205 put for $1.52.
This married put sounds great on paper.
But like everything else we do here at Stony Brook Securities, we look at the numbers…
What do we have above?
Well for short, we now have a cost basis of $217.82.
How do we figure that?
Well, we bought SPY for $216.30 and in purchasing the 205 put we paid a $1.52 debit. $216.30 + $1.52 = $217.82.
Before we get into the chances that we make money on that put…
You are instantly a $1.52 loser on your married put…congrats.
But it get’s worse…
So then the question is…
What are the chances we make money on the put?
First, we need to understand where the SPY has to get under before the 205 put becomes profitable…
If we buy a 205 put for $1.52 that means that that put does not become profitable until the SPY gets under $203.48.
Let’s check out what the delta is for SPY $203.48.
We see the 204 put with a delta of 18 and the 203 put with a delta of 16…so we will call $203.48 a 17 delta.
That means the chances of us making money on that protected put at expiration is 17%…
Who in their right mind would sign up for that…ever?
The good news is, you no longer think buying protection is a smart idea :).
Buy Inverse ETF’s
Jason recommends buying the SPXU, which is a triple inverse ETF to the S&P 500…
Let’s take a further looks.
We know that according to the Jason the SPXU is a triple leveraged ETF…meaning if the SPX is up 2%, SPXU should be down 6%.
Is that true, though?
In the last year, the SPX is up 11.12%…which should mean the SPXU would be down roughly 33%
But the SPXU (pink line above) is down 39.44%.
And like VXX, SPXU is based off futures which means…yes…SPXU has a negative drag to it because futures are in contango 80% of the time!
That is where that extra -6% comes from…
What kind of protection will that offer you…none!
Don’t buy inverse ETF’s…don’t buy VXX…just don’t.
Take Some Profits
Some of you will be shocked at my response here…
But Jason is spot on!
Taking profits is very powerful and is one of Stony Brook Securities pillars of success.
It is so powerful that taking profits can be the reason two traders with the exact same position have different profits and losses.
Don’t do it…
It adds to your cost of purchase and immediately puts you in the hole.
Not only that but the chances of it helping you protect to the downside are slim to none.
How about buying an inverse ETF or the VXX?
They have a negative drag so they aren’t as inverse as you think!
How about managing winners!
Markets are cyclical and winners can become losers overnight…
So manage your winners, book some profits, and move on to the next trade!